Judy Asks: Can Debt Relief Save the Euro?
Debt relief should be a solution of last resort if a country cannot avoid a debt deflation trap without it. This option should be combined with fiscal discipline and bold domestic reforms. It should come with a more integrated Economic and Monetary Union, with mechanisms of risk sharing to render it sustainable.
Greece has shown that mild debt relief, if postponed, can lead to steeper debt relief that becomes inevitable. Greece entered the eurozone crisis through its own reckless fiscal management up to 2009. But the decision not to allow even debt reprofiling in 2010 was a mistake. The cost was the largest combination of bailout loans and delayed debt restructuring (in 2012) and a harsh fiscal consolidation that led to over 25 percent cumulative depression and unemployment.
Locking an economy to a primary budget surplus target of 3.5 percent of GDP for years is not realistic. It is even less realistic for an economy such as Greece’s in steep disinvestment and with an employment rate close to 50 percent, undermining potential growth.
Timely and realistic debt relief in such cases is also a strategy for addressing the risk of disintegration in the Economic and Monetary Union. If the eurozone allows any member to slide toward the exit, it will be impossible to prevent the risk of currency redenomination from spreading to other vulnerable members, becoming a self-fulfilling prophecy.